This Diwali Onwards Expect More Fireworks From The Stock Market

While you will be reading this story, scores of people including you will be wishing others “Happy Diwali and a prosperous New Year”. However, looking at the current state of the stock markets, which have turned hyper-volatile, and with more trying times ahead, even I am uncertain about greeting people a “prosperous New Year”.

There is an age-old practice at the Indian bourses to hold a special trading session on the Diwali evening called the “Muhurat Trading” which is on November 7 this time. Brokers generally undertake and execute token orders on behalf of their clients including financial institutions. Market observers say, this time, it will be interesting to watch how this session ends, when the stock markets are going through turbulent times.

After peaking at the end of August 2018, the benchmark indices began witnessing correction and till date (October 23, 2018) have corrected more than 15 per cent from its peak value. The moot question that has gripped everyone associated with the market is, how the bourses are expected to behave during next three quarters, as the general elections and its results are due in June 2019. We spoke to various market participants, experts and observers to know their views on the matter as well as what investment strategies the investors should adopt, when the stock markets are expected to remain turbulent and how to keep their hard earned capital safe, secured and intact.

One of the old timers in the market made an interesting comment on the current economic state. In an oblique reference to the ensuing assembly elections in December and General Elections of 2019, he said, the Indian polity had conceived in the beginning of the last quarter of the calendar 2018 and at the end of the nine month period (ending in June 2019), we will come know whether it will deliver “Vikas” (development) or will it be a miscarriage (a fractured mandate). During this nine-month period, we (the investors) will continue to witness the “labour pain”. 

There are scores of factors responsible for the uncertain period prevailing in the markets. They range from global geo-political to domestic macro-economic factors. Systematic slowdown in China, tightening of monetary policy by the US Federal Reserve (US Fed) and weakness in equity markets across most countries worldwide is also impacting India. Apart from these factors, market sentiment is playing key role in driving volatility. Markets have been weak due to continued selling by foreign portfolio investors (FPIs) and profit booking by the retail investors. Also, as the market corrects, investors are preserving their cash and are using the current situation to restructure their portfolio.

Apart from these, there are certain factors like ensuing state assembly elections in November and their results in December and policy decisions taken by the government. Moreover, policy makers and regulators have also played their part in bringing the market to the current situation. These factors include re-introduction of long-term capital gains (LTCG) tax, reclassification of mutual fund schemes and SEBI’s decision to reduce total expense ratio (TER) for the mutual funds.

Global Factors

Exactly a year ago, the US Fed had indicated that it is going to undertake liquidity tightening by increasing the US interest rates. This had triggered the US 10-year yield to rise quickly and the world over, the markets suddenly became more volatile. The US Fed then carried out two rate hikes and one more is expected in December. The outcome of US primary election to be held during November will make the picture clearer.

Volatility has plagued the market since the start of 2018. In the last two months, there has been uncertainty driven by macro and economic factors. Investors domestically have been booking profits and are reluctant to take new position until a new bottom is formed. The ongoing earnings season might provide some relief,  if reported results are stronger  than expected.

Vipin Khare, Director, Research, William O’Neil, India, said, “The market’s current volatility spree might continue for another two-three months before FPI’s are done deciding their safe position in the Indian markets. We’ll also have to take note of the volatility to be induced by the state elections in December 2018. But even after that, since crude oil and rupee levels are unlikely to return to a comfortable level in the near future, a continued uptrend in the broader market might be difficult”.

He further said, we expect the market condition to swing between rally attempt and correction. At times, a short-term rally can deceive the investors. Hence, they should not resort to attempt bottom fishing and only go for companies that are fundamentally strong and trading above 50-day moving average, (DMA) or 200-DMA. He also advised the investors to track companies’ earnings carefully and stocks with predictable earnings growth - that are resilient in a weak market - should be identified and followed. Retail investors should create a watch list of high quality growth stocks which are delivering 20-25 per cent revenue and earnings per share growth. This is the time to patiently wait for an improvement in the overall market, added Khare.

The LTCG Impact

Indian bourses were just settling from the after effects of sudden spurt in US treasury yields in January-February and then came the budgetary announcement to levy LTCG tax on the gains made from the stock market investments including mutual funds. The new levy imposed 10 per cent on the gains and became effective from April 2018.

Until then, FPIs were the drivers of liquidity in the domestic markets like any other emerging markets in the world. However, with the US interest rates firming up, they have resorted to withdrawing funds from the domestic market and have turned net sellers in equities too. Against this, domestic mutual funds were giving a steady fight by pouring in funds, as it has been receiving consistent money through Systematic Investment Plan (SIP). However, the current volatility may take its toll and the tax incidence in the form of LTCG may discourage the investors.

 Shirish Patel, CEO, Prudent Corporate Advisory, said, “The equity investment for the retail and the high net-worth individuals (HNIs) has been tax-free for the last five-six years, as there was no tax on long-term gains. So yes, with LTCG back, there will be some immediate setback. But the one good thing is, MoF had given relied in the form of grandfatherly treatment. Now with LTCG in place, the tax arbitrage between debt and equity has narrowed down. So earlier, the inclination to go for equity was little higher, as the returns derived from it were tax-free. Over a period of time, this may come down”.

Further explaining its effect, he said, earlier, say banks were giving X returns on fixed deposits and other products, and the equity was giving Y return, which was completely tax-free. Though the returns from the equity has always been more volatile, it had its own sort of attractiveness. Not only because it was higher compared to X, but also because it was tax-free. After the introduction of LTCG, the situation has changed and investors are losing their interest. As a result, the aggressiveness with which funds were deployed in the equity segment will slow down. Even though equity has historically delivered long-term good returns, currently the uncertainty over equity to maintain Y return has increased. This uncertainty will play a crucial role in determining equity inflows, Patel added.

Speaking on the subject, on the condition of anonymity, the CEO of a leading mutual fund said, markets were expecting securities and transaction tax on the stock market  trading to be withdrawn but instead had to welcome the LTCG also. There cannot be two taxes at the same time. but in this case, there are two, which is completely a double whammy.

The Technical And Chart Analysis

All said and done, along with the macro and other apparent factors, the charts also point towards short-term weakness in the market.

Arun Kumar, Market Strategist, Reliance Securities, said, “The Nifty 50 seems to have completed its first leg of corrective actions at around 10,138.  Our proprietary greed/fear indicator for NSE500 Index displays positive signs on near-term basis. A few internal measures based on breadth and momentums are turning up from their extreme corrective zones. The “bearish” engulfing pattern on the monthly time frame has set the ball rolling downhill. Further, increasing volatility on the historical and implied basis has created more room for correction. As these measures spike to higher levels, the rush for portfolio protection will hit its peak to form a capitulation. We expect the on-going rally to terminate around 10,600 – 10,900. A reversal from near 10,600 levels could trigger a bigger fall in Nifty towards 9200 – 9500. Alternatively, a reversal in the zone of 10,900 may witness a muted fall close to 9,800. Taking cues from the time cycle perspective, the months of February 2019 and June 2019 could usher in a change of trend”.

Vikas Jain, Senior Research Analyst, RSEC, said, “The Indian equity markets will continue to remain volatile till the general election in 2019.  In 2018, India volatility index (VIX) for most part of the year has been trading in a range of 10-14 levels, but it gave a breakout in September, making a high of 21.76 levels, and now trading at 19 levels. Volatility has increased a lot over the past few weeks on account of various news flows like the liquidity concerns for non-banking finance corporations housing finance corporations, fall in rupee, higher crude prices and  global volatility”.

What Should Investors Do During Hyper Volatility?

Arun Kumar made it amply clear that considering the weak sentiments and damage to the bullish move on medium-term basis, investors/traders should exercise prudent risk management and strictly stick to their trading plans. “The elevated valuations at current level do not warrant for value picking at current juncture”.  Jain also suggested that the  Indian investors will have to live with the volatility.

“The India VIX, is expected to trade in a narrow range over the next few weeks and thereafter would start inching upwards from the middle of November, as we come closer to the results of four state elections in December. We expect the VIX index to breakout above 24 levels by middle of November and since then see it inching towards 40 over the next few months as we approach the general elections in April-May 2019,” he said.

Khare also echoed the same view and said, “Invest in pieces, multiple small investments with reasonable duration and take complete position only after general elections’ scenario is clearer - to avoid risk”.

yagnesh@outlookindia.com

(with inputs from Himali Patel and Suyash Desai)

Amandeep Singh Chopra  Group President, Head-Fixed Income, UTI MF

India’s Fiscal Woes

Chopra has been associated with UTI MF since 1994 and is responsible for new product development, fund launches and increasing fixed income fund assets. In an interview with Yagnesh Kansara and Suyash Desai he talks on volatility in the global markets, its cause and impact on Indian markets. Excerpts:

How do you see the market volatility play out in future?

The sharp market reactions occuring in India are seen in markets in the US, EU and UK as well. Volatility is here to stay as a lot of historical trends and economic theories are being tested. At least till the markets start building in some stable expectations on these variables. Some of the local factors have added fuel to the fire specifically for India.

 What impact would the tightening of quantitative easing, rising interest rates and squeezing liquidity have on India?

The moment the markets started building expectations that the Fed is going to undertake more than two hikes, the US 10-year bond yield started rising. That spilled over into the rest of the world and the yields across the world went up. Quantitative Easing (QE) roll back was not as big an issue then. It was more about Fed’s rate action than anything else. So by March, market had discounted three to four rate hikes in 2018 and the 10-year yield settled in a new range around 3 per cent mark. Today, market believes there will not be more than two to three rate hikes, one in December and may be one to two in the next calendar year.

Global liquidity has been actually very stable so far as the expansions by the European Central Bank and Japanese Central Bank have offset the decline by the Fed. However, markets are adjusting to the new reality.

 Do you see our interest rates rising in the foreseeable future?

Inflation has been surprisingly benign. Even the impact of high oil prices and currency depreciation was lowered by the government’s recent decision to lower the tax on petro products. There was an expectation built in by the markets that the currency volatility may warrant a rate hike.In the policy, the inflation numbers were tweaked downwards, particularly in the second half and presented a sign of being in RBI’s “safe” corridor. The September inflation numbers have already come at 3.8 and the next one which is expected to be released on November 12 is also expected to be low at  3-3.35 per cent. RBI has very few reason to hike raates right now.

 How do you see our macro fundamentals?

They are relatively weak and have been deteriorating since September 2017, but not as bad as where we were in 2013. Best numbers were in September 2017, when the growth had just started picking up and the news of US plans to hike the interest rate hit the market and yields world over. Today, the current account deficit has widened because of rise in crude prices and slowing exports growth. So while we are positive on growth, we remain cautious in our view on current account deficit at -2.8 per cent and risks to inflation in 2019.

 Is agrarian inflation and oil behaviour a concern for market?

Agri inflation has been managed very well. But oil has proven even best of the forecasters of commodity wrong. It is not going to give any comfort to the markets. Every $10 rise in crude prices for India adds anything between 60-70 bps to CPI inflation, and 5 per cent currency depreciation adds another 40 bps in CPI.

 Is there any correlation between QE and crude going up?

QE reversal at best could have only reduced the amount of capital available for commodity investments. Commodity prices are responding to fundamental issues. Global growth has recovered meaningfully and one of the largest consumers of oil, the US, has shown a strong growth trajectory. On the other hand, the supply side of the oil, the expected rise in the production of US shale oil production has not met with the expectation, in addition to that oil producing nations like Venezuela and Libya have their own economic problems, Iran is facing another kind of restrictions.